How House Rent Allowance is calculated?

Sandeep Shanbhag / DNA MONEY
Wednesday, 18 June , 2008, 09:02


As per my inbox, the most frequently asked question has to do with the
house rent allowance (HRA). Typically, the employee receives a certain
amount of HRA. He either already owns a flat or is about to buy one.

Consequently, he is concerned that on account of the ownership flat,
he may lose the HRA deduction. Or, the other way around — since he is
receiving HRA, the concern is that he may not be eligible for home
loan deductions.

This week, let us find out whether these fears are justified. However,
for that, we need to first understand how HRA actually works.

HRA is basically an allowance, which forms a part of one's taxable
salary. It is not mandatory for the employer to give HRA. But, if an
employer chooses to offer the allowance, one will receive it whether
or not he owns a house, pays EMI on the home loan, pays rent, or lives
with his parents.

In other words, the HRA, like the basic salary, is received every
month, regardless of one's personal situation.

However, the law also provides that if the employee satisfies certain
conditions, a deduction will be provided from the HRA received and
only the balance will be subject to tax. This deduction depends upon
the city one lives in and the amount of rent he pays. We shall discuss
this in detail a little later.

Let us first address the issue we started out with. What if you get
HRA and also own a house? Does this affect either the HRA deduction or
the home loan deductions?

The answer is no. HRA and home loan provisions are two different
issues as far as the Income Tax Act is concerned and one does not
influence the other. So, you may own a flat or any number of flats,
either in the same city that you work in or anywhere else in the whole
of India or for that matter abroad.

This will, in no way, influence the HRA deduction that you are
entitled to. Conversely, notwithstanding the amount of HRA that you
receive, your home loan deductions on the EMIs for the house you have
bought or intend to buy will not be affected.

Now, let's move on to understanding how much HRA deduction you would
be eligible for and the way to calculate it. As mentioned before, the
HRA is provided by the employer.

However, a deduction thereon is provided by the Income Tax Act,
subject to fulfilment of certain conditions.

The first and the foremost condition is that you have to be paying
rent. After all, that is what the allowance is meant for in the first
place. So, if you are one of the lucky few who do not have to pay rent
for the roof over your head, you don't get the deduction.

Note that it is not necessary for you to pay rent to a landlord. It is
possible that you live in your parents' house, in which case, you may
pay rent to your parents and consequently be eligible for the HRA
deduction.

In this case, the rent received will be taxable for your parents —
however, if their total income is below the taxable limit, the entire
transaction would be rendered tax-free.

As per the provisions of the Finance Act, 2008, Rs 2,25,000 is tax-
free for a senior citizen. Split between mom and dad, the total amount
of rent could be much as Rs 4,50,000 (Rs 2,25,000 x 2) without tax
incidence. So, you get your HRA deduction, they don't pay any tax and
everyone wins.

But, let me clarify that the same structure cannot be adopted in the
case of your spouse. Yes, it would be very convenient to pay rent to
the non-working spouse and thereby save a load of tax. But, if only
life were that simple! Husband and wife cannot charge each other rent
as they are supposed to live together under the same roof.

In other words, the relationship between husband and wife cannot be
commercial in nature.

The other factor that influences the HRA deduction is where you live.
If you live in a metro city, you would be eligible for a deduction of
up to 50% of your salary (basic plus DA, if applicable); otherwise,
the limit is 40%.

So, in a nutshell, the HRA deduction is the least of the following:

i. Actual HRA received,

ii. 50% of salary for employees living in metros and 40% otherwise,
and

iii. Excess of the rent paid over 10% of salary.

Say, Vikram earns a basic salary of Rs 35,000 per month and rents an
apartment in Mumbai for Rs 15,000 per month. The actual HRA he
receives is Rs 20,000. Vikram's HRA deduction will be the least of the
following three figures:

i. Actual HRA received, i.e. Rs 20,000,

ii. 50% of the salary, i.e. Rs 17,500, and

iii. Excess of rent paid over 10% of salary, i.e. Rs 15,000 - Rs 3,500
= Rs 11,500.

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Therefore, the net taxable HRA for Vikram would work out to Rs 20,000
(HRA received) less Rs 11,500 (HRA deduction available), which works
out to Rs 8,500.

Last but not the least, don't forget to maintain the rent receipts or
a copy of the lease agreement as this serves as proof of having paid
the rent.